The Good, the Bad and the Ugly of the Fed rate hike!!

   Schwaben Blog

December 18, 2015

 

 

Weekly Statistics:

  Today Week Ago Year Ago
  18-Dec-15 11-Dec-15 18-Dec-14
       
S&P TSX 13,024 12,742 15,417
S&P 500 2,006 2,017 2,089
DJIA 17,129 17,266 17,819
OIL $34.55 $35.56 $68.86
USD vs CAD 0.7165 0.7278 0.8503
Gold $1,066 $1,078 $1,174

 

The Federal Reserve raised interest rates for the first time in a decade, pointing towards a healthier and a stronger US economy. The board members of the Federal Open Market Committee (FOMC) voted unanimously for this rate hike. The U.S. central bank’s policy-setting committee raised the range of its benchmark interest rate by a quarter of a percentage point to between 0.25 percent and 0.50 percent, ending a lengthy debate about whether the economy was strong enough to withstand higher borrowing costs. Many economists see this rate hike as a vote of confidence in the US economy. The central bank clarified that the rate hike was a tentative beginning to a “gradual” tightening cycle, and that in deciding its next move it would give more importance on monitoring inflation, which remains well below the Fed’s target rate of 2%. A Dec. 9 Reuters poll showed economists forecasting the federal funds rate to be 1.0 percent to 1.25 percent by the end of 2016 and 2.25 percent by the end of 2017. Equity markets applauded the rate hike and rose sharply on Wednesday after the announcement, but markets lost their gains and fell subsequently on Thursday and Friday. The main reasons for the subsequent drop in equity markets are the rising US dollar and falling oil prices falling $35 per barrel (first time in last seven years). Today is a big options expiry day- a day when futures and options contracts expire- which is likely adding to volatility. The chart below depicts the US Fed funds rate, which peaked at 5.25% in 2006 and stayed at almost 0% since 2009.

 

Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading Economics

Are we in for a rate hike in December?

   Schwaben Blog

November 06, 2015

Weekly Statistics:

Today Week Ago Year Ago
06-Nov-15 30-Oct-15 07-Nov-14
S&P TSX 13,553 13,525 14,690
S&P 500 2,033 2,079 2,031
DJIA 17,910 17,662 17,573
OIL $44.52 $46.59  $78.61
USD vs CAD 0.7537 0.7650 0.8827
Gold $1,088 $1,141  $1,146

With the release of October Payroll report the fear of an interest rate hike as soon as December is back on the table. After last week’s report that the US economy posted a disappointing growth of just 1.5 percent (annualized) in Q3 2015, investors discounted the probability of a rate hike anytime soon and started getting back into equities. But today’s jobs report left little doubt that the US economy is growing again. The gain of 271,000 in payrolls was the biggest this year and exceeded analysts’ expectations of a gain of 185,000. After almost eight years, the US economy now has more civilians working in full-time jobs than it had before the financial crisis of 2007/08. According to CME FedWatch tool, there is a 70 % probability of a rate hike during FOMC meeting in December. Also, if the interest rates are increased, then there is a 69.8% probability of a 50 basis points hike and 30% probability of a 25 basis points hike. Last week, the probability of just a rate hike was less than 30%. I still think that the likelihood of an increase in interest rates is around 30-40%.  Even though employment numbers have far exceeded the expectations, the average blended earnings growth for S&P 500 is -2.2%. If the index reports an earnings decline in Q3, it will be the first back-to-back quarters of earnings declines since 2009. According to Factset, 76% of companies are reporting EPS above estimates. This is above the 5 year average earning surprise for the index, while only 47% of the companies are reporting sales above estimates. With interest rates at record lows, companies are buying back their shares at a record pace and this raises EPS. The share buyback increases EPS however it may not be a sign of significantly increased earnings. Although employment gains last month were a lot stronger than expected it may not necessarily point to an excessively growing US economy.

Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading Economics

Reasons for the Recent Rally in Equity Markets.

   Schwaben Blog

October 23, 2015

Weekly Statistics:

Today Week Ago Year Ago
23-Oct-15 16-Oct-15 23-Oct-14
S&P TSX 13,953 13,838 14,227
S&P 500 2,075 2,033 1,950
DJIA 17,647 17,216 16,677
OIL $44.33 $47.17 $80.39
USD vs CAD 0.7657 0.7757 0.9012
Gold $1,164 $1,177 $1,233

The consecutive announcements by the European Central Bank (ECB) and the People’s Bank of China (PBOC) on Thursday and Friday respectively drove equity indices higher. The ECB signaled that it would expand its $1.28 Trillion quantitative easing program in December and cut its deposit rate if the slowdown in emerging economies threatens the eurozone’s economic recovery. Furthermore, the Chinese central bank dropped their benchmark interest rates by 25 bps. Many analysts are viewing this cut in interest rate as a measure by Chinese leaders to spur the country’s economic growth to their target of 7 percent. The reduction in interest rates is planned to stimulate the growth of the Chinese economy and stimulate global equity markets. Unexpected smaller declines in profits in US equities also drive the recovery in equity indices from a few months ago. 77 percent of the 173 companies that have reported their earnings for Q3 2015 have reported above expectations. On September 30, the estimated earnings decline for the S&P 500 for Q3 2015 was -5.1 percent. As of today, the earnings decline has been revised to -3.8 percent. Upside earnings surprises by companies in the Information Technology, Consumer Discretionary, and Telecom Services sectors accounted for most of the decrease in the earnings decline for the index. Microsoft, McDonald’s, Amazon, AT&T, GM as well as other Blue Chip equities had a positive impact in their respective sectors. Energy and Materials are the largest contributors to the earning declines across all sectors.

Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading Economics

Will the S&P 500 Miss the Earnings Estimate Again?

   Schwaben Blog

October 09, 2015

Weekly Statistics:

Today Week Ago Year Ago
09-Oct-15 02-Oct-15 09-Oct-14
S&P TSX 13,964 13,340 15,086
S&P 500 2,015 1,951 1,906
DJIA 17,084 16,472 16,544
OIL $49.49 $45.63  $83.58
USD vs CAD 0.7725 0.7507 0.9062
Gold $1,156 $1,137  $1,225

The minutes from FOMC’s September meeting were recently released and they clearly indicated that the members of Federal Reserve were more inclined towards raising the interest rates but did not do so because of fears of global slowdown. According to the minutes of the meeting, “ Participants anticipated that recent global developments would likely put further downward pressure on inflation in the near term; compared with their previous forecasts, more now saw the risks to inflation as tilted to the downside”. Although this led to sharp correction in the equity indices but the overall sentiment since the last meeting has greatly improved. Investors seem to have discounted the probability of a rate hike in October or probably even in December and a rally of around 4 percent (week-over-week) followed across the major indices of the US and Canada, but it does not mean that the outlook is certainly positive for equities. Earnings drive stock prices and with valuations at historical highs, it will take decent to strong earnings for this bull market to continue. According to FactSet, for Q3 2015, the average estimate for earnings decline is -5.5 percent for S&P 500. If the index reports a decline in earnings for Q3, it will mark the first back-to-back quarters of earnings decline since 2009. Only 5 percent of the S&P 500 companies have reported their earnings till now and many heavyweights like Intel, Johnson and Johnson, Kinder Morgan, JP Morgan etc. are reporting next week. Of the companies that have already reported their earnings, consumer driven companies like Nike, Costco have delivered strong results but industrials like Alcoa have disappointed the investors.  Slowing Chinese economy and a strong dollar could again be made the scapegoats and many companies have already cited a stronger dollar to have a negative impact on their Q3 earnings.

The US Economy Slowing Down?

   Schwaben Blog

October 02, 2015

Weekly Statistics:

Today Week Ago Year Ago
02-Oct-15 25-Sep-15 02-Oct-14
S&P TSX 13,340 13,380 15,026
S&P 500 1,951 1,931 1,965
DJIA 16,472 16,315 16,945
OIL $45.63 $45.58  $89.37
USD vs CAD 0.7507 0.7507 0.9051
Gold $1,137 $1,146  $1,226

With only two weeks left for the October FOMC meeting, it certainly doesn’t look like a rate hike is on the Fed’s agenda. The disappointing unemployment report for the US economy justifies the Fed’s decision to not to raise the interest rates during their last meeting. In September, the US economy added a seasonally adjusted 142,00 jobs compared with analysts’ expectation for a gain of 200,000 jobs. This is the second month of disappointing unemployment numbers, after the US economy added only 136,000 jobs in august compared with analysts’ expectation of 173,000. A significant correction in oil prices during last one year has led to mounting losses/ bankruptcies for many energy companies and they have cut 120,000 positions since December 2014. The longer the oil prices stay low, the deeper the losses for energy companies, and therefore more layoffs. These layoffs could be one of the reason for disappointing unemployment numbers since last two months. After deciding to keep interest rates steady during the last meeting in September, the Federal reserve chairperson, Janet Yellen, commented that most members on Federal Open Market Committee (FOMC) still expect a rate increase in 2015, but I believe that a rate hike in the first quarter of 2016 would be more prosperous for the US economy. The poor unemployment numbers in the last two months could also mean the economy did not grow at a decent pace in the third quarter. At a time when global economies were slowing down, the US economy grew at 3.9 percent in the second quarter and a dismal performance in the third quarter   would cast serious doubts over the strength of the economy.

Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading EconomicsUS Jobless Sep 2015

The US Dollar and The Interest Rates

   Schwaben Blog

September 25, 2015

Weekly Statistics:

Today Week Ago Year Ago
25-Sep-15 18-Sep-15 25-Sep-14
S&P TSX 13,380 13,646 15,026
S&P 500 1,931 1,958 1,965
DJIA 16,315 16,385 16,945
OIL $45.58 $44.92  $89.37
USD vs CAD 0.7507 0.7604 0.9051
Gold $1,146 $1,138  $1,226

After deciding to keep interest rates steady during the last meeting, the Federal reserve chairperson, Janet Yellen, commented yesterday that most members on Federal Open Market Committee (FOMC) still expect a rate increase in 2015. She also said that “Prospects for the US economy generally appear solid”. Her comments are supported by this morning’s report from the Commerce department, which states that the US economy grew at an annual rate of 3.9 percent compared to the previous forecast of 3.7 percent. A significant correction in oil prices could also be partially responsible for this stellar growth. This boosted the confidence of investors after the last FOMC meeting gave them some jitters about the growth of the US economy. Most of the major economic indicators are pointing towards a healthy and growing economy, and raising interest rates by 25bps would not prove catastrophic. Although there could  be a short-term correction in equity markets, a hike in interest rates would  signal that the US economy is strong enough to absorb a rate hike after almost a decade, however this does not alleviate the concern of falling inflation especially with a rise in interest rates. A stronger dollar could also  lower inflation as it suppresses import prices. The US dollar index, which measures the performance of US dollar against a basket of six currencies, has significantly appreciated on a year-over-year basis and is almost at the highest level for a decade resulting in disinflation for US consumers.

Source- Bloomberg, Globe Investor Gold, Financial Post, Market Watch, Trading Economics